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"[P]revious studies show that 12b-1 plan expenses are deadweight costs and that these expenses do not reduce costs for shareholders."
--Malhotra, Martin, and Russel [2007]
I n general terms,firm economies of scale provide cost reductions obtained from increasing asset size. Costs per unit of output decrease with increasing scale and constant variable costs as fixed costs are spread over more units of output. Operational efficiency is also often higher, with increasing scale leading to lower variable costs. In the case of mutual funds , there are fixed costs that go toward reducing the ratio of fund expenses to total net assets as assets increase.
Mutual funds are basically firms with inputs of financial and human capital. Fund outputs are sets of portfolio securities. It appears there are limits to human capital that can be productively added to funds. Research continues to explore these and other limits.
The Investment Company Institute (ICI), the fund industry trade association, provides a more inclusive statement of economies of scale:
Afirm having economies of scale is able to increase output with a less than proportional increase in labor and capital inputs by relying on efficiencies in the production process. Applying standard concepts of the firm to a financial organization, including amutual fund , is not straightforward because of difficulty in defining and measuring output. Assets are the typical measure of output, but they may not capture the full range of services provided by a mutual fund. (Rea, Reid, and Millar [1999])
The ICI then describes economies of scale formutual funds :
Advisory and administrative fees are determined by contract and typically are computed as a percentage of assets.... The declining rate schedule reflects the expectation that cost efficiencies or scale economies will be realized in the management and administration of the fund's portfolio and operations as the fund grows. Such efficiencies do not generally arise from the spreading of fixed management costs across larger asset levels, as is often assumed. In fact, fund asset growth typically necessitates additional resources for portfolio management, investment research, and administration. Thus, the declining fee schedule results from anticipated efficiencies in the processes of the adviser and administrator as they add labor and capital to expand the scale of their...